2023-05-31 23:59:03 ET
Summary
- KOMP provides comprehensive exposure to innovative industries, which drives the fourth industrial revolution.
- The fund is highly diversified and includes both market leaders and young, advanced companies, with a focus on mid and small cap players.
- I believe the KOMP has a 15% upside potential against the backdrop of the secular shift to the “new economies”.
The rapid development of AI, cloud computing, big data, machine learning, and robotics could become the foundation for new innovations. The current technological and technical base is conducive to the Fourth Industrial Revolution gaining momentum, and I believe that SPDR S&P Kensho New Economies Composite ETF ( KOMP ) is a reasonable tool to capitalize on the mentioned positive trends. In particular, KOMP gives investors more comprehensive exposure to innovative industries than the S&P 500 and NASDAQ 100 indices, as well as industry-focused indices and funds. I believe that it is reasonable to participate in the growth of new industries and innovative technologies through investment in KOMP, as it is highly diversified and includes both market leaders and young, advanced companies.
Fund’s overview
KOMP is established to mirror the performance of the S&P Kensho New Economies Composite Index, which covers more than 20 areas of the new economy, such as AI, robotics, automation, VR and AR, nanotechnology, 3D printing, blockchain, etc. The aforementioned areas are in many respects revolutionary, destroying the traditional economic structure and are an integral part of the fourth industrial revolution, which is already underway. Thus, KOMP provides an attractive opportunity to gain exposure to innovative industries with significant long-term potential and capitalize on the growth of the "new economy".
The funds benchmark employs a unique methodology of selection of issuers to be included in the index. The selection is not based on quantitative criteria, instead, the power of AI and Natural Language Processing (“NLP”) are used to scan the regulatory filings, searching for key innovative terms and words relevant to the respective new economy sectors. Out of the selected candidates, 25 sub-indices are formed, which serve as a basis for the index. The risk/return ratio of each sub-index and the stage of the innovation life cycle are also taken into consideration.
The primary advantage of the methodology is high diversification, especially compared to industry-focused ETFs, and relatively level exposure across the spectrum of capitalization and different sectors of the economy.
As of May 26, 2023, the fund manages assets in the amount of $1.66 billion, which costs the investors a relatively low 0.20% on annum.
The top 10 holdings out of 550 overall occupy about 10% of the fund, while the top 50 account for 31%. We can find in the above list Bruker Corporation ( BRKR ), Teledyne Technologies ( TDY ), Liquidia Corporation ( LQDA ), PTC Inc. ( PTC ), Elbit Systems ( ESLT ), Embraer S.A. ( ERJ ), Leidos Holdings ( LDOS ) – the names, which may not be familiar, but their presence among the fund’s top holdings is dictated by methodology.
KOMP doesn’t focus on players with large capitalization as well, where only 37.4% of the fund is composed of issuers with more than $12.9 billion in capitalization. A significant attention is provided to mid and small cap players (54 % of the fund) and even micro caps (8% of the fund).
Innovations are not only the prerogative of the IT sector, as merely 35% of the fund belongs to the high-tech sector. The industrials (24.1% weight) and healthcare (19.4% weight) also carry a significant fraction. The composition of the fund overlaps only 29% with the composition of the S&P 500 index and 13% with the NASDAQ 100. As a result, KOMP provides additional access to innovative companies that are not included in the basic and sectorial indices.
Being broad-market oriented, KOMP correlates quite closely with the S&P 500. However, considering the performance of the fund since its inception, KOMP clearly underperformed the S&P 500 index, represented by SPY in the following chart.
It's obvious that the underperformance started from 2022, which could be explained by the unfavorable macro picture and recessionary fears forcing businesses to tighten their belts and cut the budget for IT spending and investment in innovation. And if we assume that low interest rates have been previously taken for granted, the current reality of elevated interest rates hinders the funding of innovations. The most obvious point for the lag is related to the fact that big techs do not have as much weight in the fund as they do in the SPY. However, in the long-term view, I believe that there is a decent upside to come in the light of the secular shift to the “new economies”.
Prospects for innovations
The rapid development of AI, cloud computing, big data analytics, IoT, robotics and ML algorithms are becoming a foundation of future innovations. Back in 2020, the pandemic additionally spurred the development of these fundamental technologies, which are extremely favorable for the fourth industrial revolution. Since the advent of the Internet and smartphones, so far, all factors indicate that the AI will be the basis of a new technological cycle. The beginning of 2023 was just marked by a new wave of mass interest in artificial intelligence, with Microsoft ( MSFT ) investing 10$ billion in ChatGPT developer OpenAI. But AI is not just a breakthrough technology, it also could act as a foundation for future developments or take current solutions to another level. But AI is not just a breakthrough technology, it also could act as a foundation for future developments or take current solutions to another level. Nowadays, AI-powered solutions find increasing application in all industries and their widespread adoption could increase total factor productivity (according to Cobb-Douglas production function) and drive a 7% expansion in global GDP over the next 10 years . In particular, global spending on AI , including software, hardware and services could surpass $300 billion in 2026 from $118 billion last year, which implies a 26.5% CAGR over the period.
Going further, not only the artificial intelligence area is a spotlight of the investments and innovations. There are some other, not less promising sectors in the new economy. In particular, the renewable energy industry is currently attracting a lot of investments against the backdrop of climate pressure. For reference, about 85% of global electricity production could come from renewables, primary solar PV and onshore wind .
With the widespread digitalization and increasing number of technologies, cybersecurity is becoming a necessary aspect of business. Enterprises can’t afford to cut security expenditures as this would leave them vulnerable . And last but not least, the aerospace, IoT and medicine &pharmaceuticals may incentive the development of new technologies as well, and become a significant growth points in the “new economy”.
Valuation
KOMP distributes dividend payments to shareholders on a quarterly basis. For the last 12 months, the fund paid out $0.59 per share, delivering a yield of 1.43%.
In order to assess the potential upside of KOMP, we can turn to the consensus estimate for the S&P 500 index. Currently, the consensus forecast for the next 12 months stands at 4 750 points, where the latest value of the index at 4 205 implies an upside of 13%. Taking the beta coefficient of the fund, which comes at 1.17x, the growth potential of the fund could be estimated at 15.2%, excluding dividends. Thus, in my view, it’s reasonable to expect a price of $47.25 per share, which is in line with a Buy recommendation.
Risk factors
The main risks for the KOMP are associated with the elevated interest rates environment without a clear pathway of the Fed’s actions, and increased volatility in the U.S. market. In addition, the fears about the onset of a recession and a banking crisis should not be underestimated.
Conclusion
KOMP covers 25 innovative areas of the “new economy” which appears to be an integral part of the fourth industrial revolution, and could become a center of gravity for investment in the years to come. Thanks to an AI and NLP based methodology, the fund is highly diversified, which provides for a relatively balanced performance and lower overall portfolio risk and volatility. If we examine closely the fund's constituents, some may appear to be clearly overvalued. In the article I didn’t touch this point as it shouldn’t be a surprise that investors are willing to take a premium for the players with the potential for disruption and innovation.
For further details see:
KOMP: Catching The Shift Towards New Economies